Modeling Long-Term Government Bond Yields: An Efficient Market Approach

Movements in long-term Treasury bond (T-bond) rates directly influence interest rate sensitive sectors such as agriculture. More specifically, T-bond yields underpin private intermediate and long-term lending rates such as long-term agricultural mortgage and farm equipment loans. Because of this, forecasts of long-term lending rates for agriculture must begin with forecast assumptions concerning the T-bonds. This report builds upon previous empirical work that indicates term premiums on bonds are variable and partly predictable over time. The model developed here also accounts for increasing globalization of financial markets and the increased substitutability of foreign and U.S. bonds. This report constructs a model for generating forecasts of T-bond rates that can be used as an input in predicting specific agricultural long-term interest rates.